Sunday, June 11, 2017

Synergy mirage of Reliance foray into retail fuel business.

I agree with the HBR paper “The Coherence Premium” Paul Leinwand and Cesare Mainardi that companies should focus on their core capabilities and not try to expand into adjacent areas of business which do not enhance their differentiated capabilities. Upon reading the article one example which came to my mind was Reliance Industries Limited (RIL), which is an Indian conglomerate which operates the eighth largest energy company in the world. RIL’s Jamnagar Refinery is the largest oil refinery in the world. RIL’s core capabilities in energy area are refining crude oil into a variety of petrochemical products. Reliance Industries entered the fuel retaining business in 2006 trying to sell its refined petroleum and diesel directly to customers by opening fuel pumps across the country. By 2008 they gained 14% in of the retail market dominated by state owned oil companies oil companies like IOCL, HPCL and BPCL. RIL seemed to have made a master stroke in terms of strategy by entering the retail fuel business, however in March 2008 RIL decided[1][2] to shut all its retail fuel stations owing to mounting losses triggered by sharp increases in crude oil prices. I think this is an example of ‘The Synergy Mirage’ as discussed in the HBR’s Seven ways to Fail Big article written by Paul B. Carroll and Chunka Mui.
Retail fuel market in India was a completely different ball game compared to RIL’s oil refining business. Crude oil and petrochemical product prices are dictated by world markets and RIL has been operating in this area for a long time and it knew how to profit from it. Retail fuel market in India is however tightly controlled for decades by the government as it subsidizes fuel sold by state owned oil companies in an attempt to keep inflation (CPI) in check. India is big importer of crude oil as it hardly has any oil reserves of its own within the country. So consumer prices of general commodities is directly related the price of crude oil in international markets. From time to time to soften the blow of increasing cost of crude oil prices on general population, Indian federal government intervened to subsidize fuel prices by giving money to state owned oil companies to compensate for lower retail prices decided by the government. Government did not subsidize fuel sold by private operators like RIL and Essar which just could not compete on prices with state owned oil companies which enjoyed state support.
Until private firms like RIL and Essar entered the retail fuel market state owned companies owned 100% of the retail market. While RIL designed the strategy to enter the retail market dominated by state owned oil companies, the subsidy provided by the government was very low for several years as the oil prices were quite stable. But RIL did not have the strategic foresight to think or understand about the regulations and rules of the retail fuel game. They just did not anticipate the oil prices sky rocket so fast. The reason for the mistakes they made could be because of the lack of experience in the Indian oil retail business. On paper the synergies seemed very obvious but they did not understand the business well.
 RIL in 2016 planned to open[3] its retail fuel chain again as the government has deregulated the oil industry, this time round there will be level playing field as state owned oil companies will not get any government subsidies. Its original decision in 2006 was clearly ill advised and ahead of its time. They should have first lobbied the government to deregulate the industry and waited for it to happen before entering the market.


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